A notable economic feature of late is the inexorable rise in US interest rates, and its consequential effect on rates elsewhere, and market valuations. Equally notable is the escalation of trade disputes, most particularly between the United States and China. This shift towards greater protectionism by the United States could, if not mitigated, trigger more dramatic retaliatory actions, possibly including currency devaluations, and stands as a primary market risk as we look to the remainder of 2018 and into 2019.

Saving Ratio

In Australia, economic conditions remain benign. Economic activity and inflation have risen modestly, interest rates have remained largely steady this year, and shares were trending higher till a recent sharp sell-off. Much of the growth in consumer consumption has come from a draw-down in savings. As household debt remains extremely elevated and savings diminish, there is not much margin for error should interest rates rise.

The Australian dollar has been under pressure, falling to multi-year lows against the Euro and $US, primarily due to a capital exodus to the higher interest rate US Dollar. The Reserve Bank’s inclination to keep interest rates very low might keep the currency weak, but this could be counterbalanced by the improved energy and iron ore commodity prices.

Australian Shares

Global Shares

On a like-for like basis, the cyclically adjusted PE ratio indicates more prospective investment valuations from German and Japanese shares, relative to the United States.

Property Securities

The stock market prices of listed property securities (REIT’s) are susceptible to variations in interest rates, so it is no surprise that some REIT prices fell sharply recently, in the immediate wake of rising US bond yields. This retraction in prices also reflects the heightened valuations of some underlying real estate assets, and the possibility of a slower rate of appreciation ahead. Corporate activity continues, notably the contested offer for the Investa Office Fund – the competing acquirers both having foreign backing, and probably benefitting from the low $A.

The development cycle in the Sydney and Melbourne CBD’s remains very strong, particularly in Sydney where the Metro rail project has created multiple new commercial sites, in addition to the already significant pipeline. Consequently, oversupply risks are likely to arise as many of these projects complete in 2020/21.

Residential real estate prices are falling in much of Australia, reversing a period of strong growth. Tighter credit criteria, concerns about elevated houshold debt, a waning of foreign investment and pockets of oversupply are responsible. The outlook is subdued, with some areas likely to suffer further demand and price decline, before stabilising.

Interest Rates

The Reserve Bank of Australia (RBA) is persevering with its stable 1.5% cash interest rate setting, a position it has held since August 2016. Consequently, the RBA has allowed the interest rate differential with the US to widen, (US rates are rising whilst ours are steady), and this has led to a weaker Australian dollar, a premeditated strategy that has helped support export related economic activity.

Long dated Australian bonds have been remarkably steady, exhibiting a very narrow range of 2.5% to 2.9% for nearly two years. The lack of perceived inflation risk, stubbornly low wage growth and inactivity by the RBA have contributed to this stability in rates. Similarly, credit spreads have remained fairly narrow, meaning that the availability and cost of finance have both been satisfactory. However, in recent months, credit assessment conditions for household mortgages has tightened, driven by prudence, economic necessity and more stringent regulatory settings. Such conditions might exacerbate an already weakening housing market, which in turn may lead to a softening of economic activity – circumstances that the RBA would see as justification for maintaining their 1.5% policy setting well into 2019.

Meanwhile, the US Federal Reserve’s well-advertised program of rate increases continues, now with a bit more fanfare as the prospect for higher rates is causing some market angst. The Fed has indicated the likelihood of a further 0.25% rise in December, and another three such increases in 2019. US rates are now higher than comparable Australian rates, and this widening differential is likely to cause the Australian dollar to remain relatively weak.

The stable interest rate conditions in Australia have allowed hybrid prices, credit spreads and trading margins to temporarily shed some volatility. Interest bearing investments that carry risk, such as hybrids, have performed well, but investors need to be aware that such instruments can suffer sharp market price volatility when credit conditions deteriorate.

Outlook

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This publication has been prepared by Joseph Palmer Sons (ABN 29 548 490 818) an Australian Financial Services Licensee (AFSL 247067). Whilst the information contained in this publication has been prepared with all reasonable care from sources, which Joseph Palmer Sons believes are reliable, no responsibility or liability is accepted by Joseph Palmer Sons for any errors or omissions or misstatements however caused. Any opinions, forecasts or recommendations reflects the judgment and assumptions of Joseph Palmer Sons as at the date of publication and may change without notice. Joseph Palmer Sons, their officers, agents and employees exclude all liability whatsoever, in negligence or otherwise, for any loss or damage relating to this document to the full extent permitted by law. This publication is not and should not be construed as an offer to sell or the solicitation of an offer to purchase or subscribe for any investment. Any securities recommendation contained in this publication is unsolicited general information only. Joseph Palmer Sons are not aware that any recipient intends to rely on this publication and are not aware of the manner in which a recipient intends to use it. In preparing our information, it is not possible to take into consideration the investment objectives, financial situation or particular needs of any individual recipient. Investors must obtain individual financial advice from their investment advisor to determine whether recommendations contained in this publication are appropriate to their personal investment objectives, financial situation or particular needs before acting on any such recommendations.